LORD COPPER: What to do about aluminium?

What has happened in the aluminium market since 2008 would seem to be more than a blip while the market rebalances. So what is going on?

One of the guiding principles of economics is that the market prices of goods are determined by supply and demand. At least, I had better qualify that: in capitalist, free market economics.

Statists probably should look away now.

But in our system, over the long term, the interplay of demand and supply is what sets the clearing price of the goods and services that we exchange. That doesn’t mean there will never be over- or under-supply, but that if either of those happens, then, again over the long run, the interaction of price with supply and demand should restore market balance. This is a pretty basic principle.

Now, going beyond the theoretical to the practical particulars of the metals and mining industry, reality, as ever, is more complicated.

Certainly, the concept holds good, but the nature of mining is such that there will always be a time-lag while the market adjusts; because of this, the market can see periods of excess supply or demand which inevitably cause price spikes or dips while the mechanics of adjustment are going on.

What has happened in the aluminium market since 2008, though, would seem to be more than a blip while the market rebalances.

How did we get here?
Just to recap for a moment; through 2007, the global economy was still growing and with it the size of the aluminium market. At that point, the financial crisis brought both to a shuddering halt.

Now, that change in global growth prospects – a proxy for demand – should have instigated a round of production cuts to keep the market in balance and prevent an increasing oversupply with the concomitant risk of a price collapse.

But that didn’t happen.

The availability of storage space and very cheap money offered an alternative. Instead of cutting production – which no producer, quite reasonably, wants to do – it could be maintained and the excess parked as collateral for a financing deal, which was attractive to banks licking their wounds from risky property loans and looking for a more secure alternative.

Had the slowdown lasted six months or a year, perhaps that tactic could have been digested.

However, it’s now in its fifth year, and although some more encouraging signs are beginning to appear (and, belatedly, production cuts have to an extent occurred), nevertheless the aluminium market has been in surplus for all of that time, resulting in an LME stock in excess of 5 million tonnes and a non-LME stock of probably at least the same.

The aluminium surplus this year is substantially smaller than had been expected – but it is still a surplus – and some analysts are in fact predicting a small deficit next year.

So all is well, then, and we can look for the price to start rising again?

Grounds for optimism?
That’s the conclusion I read in a survey by one group of analysts, but I think they’re being too optimistic. There have been production cuts over the past couple of years, but they have been temporary – in other words, plants were idled but not permanently closed – meaning that they are able to be reactivated in the future.

The history of the past five years frankly shows us that the aluminium industry – and again, I would stress, quite understandably – is not enamoured of production cuts, so it is difficult not to believe that currently shuttered plants will be reopened as soon as the picture looks rosier. At the same time, there is a substantial stock overhang which has to be worked off.

It’s an unfortunate quirk of the way that stock exists that it may appear to be unavailable, but it would be naïve not to understand that despite that it will still act as a brake on the market while it is there.

Production increases will probably not occur while prices remain low, but the threat of them will prevent prices rising too far; that’s the unfortunate vicious circle that the industry has got itself into.

Optimists – like the analysts I mentioned above – may still say that prices will rise as economies recover, but I’m afraid I can’t share that optimism.

Unfortunately, I think prices have to drop further before the industry grasps the nettle: something as drastic as the closure of all Japanese smelting in the 1980s is going to have to happen to put the industry back on a more stable footing.

Lord Copper 
editorial@metalbulletin.com